Apple’s Problem: China’s Economy or Loss of Market Share?

At the end of the first day of trading in the New Year, Apple announced that it was cutting its revenue guidance. Tim Cook, Apple’s CEO, blamed a slowing Chinese economy and the impact of the trade war between the United States and China for the reduced guidance. In a letter to investors, Cook said:

“While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China … China’s economy began to slow in the second half of 2018. The government-reported GDP growth during the September quarter was the second lowest in the last 25 years. We believe the economic environment in China has been further impacted by rising trade tensions with the United States.”

Is China’s economy really to blame for Apple’s shortfall as Cook claims, or is there another reason why Apple’s sales are hitting the wall in the country? While China is Apple’s third largest market by sales, there are growing signs that the company’s market share has slipped badly in recent years. Remember Motorola and Nokia? Both were early leaders in cell phones, not only in China, but also globally. Neither company exists today. The remnants of Motorola were purchased by Lenovo in 2014, and Nokia was purchased by Microsoft in 2013. Even big, successful companies can and do fail. It happens all of the time, particularly when strong market forces are at work like those in China today.

With respect to China’s economy, it is true that GDP growth is falling, but the “magnitude of the economic deceleration” is not nearly as large as Cook suggests. In the final quarter of 2017 and the first quarter of 2018, China’s economy grew by 6.8 percent. From there, it fell to 6.7 percent in the second quarter, and 6.5 percent in the third quarter, which happens to be China’s official, published growth target for the entire year. For 2019, the International Monetary Fund (“IMF”) has predicted that China’s economy would grow by 6.2 percent, down from an earlier forecast of 6.4 percent, citing the “negative effect of recent tariff actions.”

While tariffs may take 0.2 percentage points off of China’s growth rate in 2019, the impact of the trade war in 2018 has been more psychological in nature. Due to negative investor sentiment caused by trade tensions, the renminbi, China’s currency, is lower by about 8.0 percent against the dollar, and the Shanghai Stock Exchange closed the year 25 percent lower, its worst performance in 10 years. Meanwhile, in the real economy, exports to the United States have increased by 8.0 percent through October, the latest month for which data is available. Also, China’s overall export growth accelerated from 9.8 percent in August to 14.5 percent in September, with analysts predicting that exports will have expanded by 8.7 percent for all of 2018.

Rather than the trade war dragging down China’s economy in 2018 as Cook suggests, the deleveraging campaign that China began implementing in late 2017 is the major cause of the slowdown. In order to de-risk its financial sector, China has been restricting the overall growth in credit. This, in turn, has led to fewer loans available for corporations; the collapse of many online lending platforms; a greatly reduced level of margin debt; and a dramatic decline in shadow lending.

If not the economy, why are Apple’s sales in China slumping? It’s quite simple: more and more local competitors have come on the scene, and every year they, as a group, are producing more and better smartphones that are more affordable and that Chinese consumers want to buy.

As in most industries these days, the China smartphone market is one of the largest in the world. In 2017, there were approximately 660 million smartphone users in China, about one-third of the two billion users worldwide. In that year, there were 454.4 million smartphones shipped in the country, which means that Chinese users are replacing their smartphones about every eighteen months. Therefore, having new models and features is important. Of the smartphones shipped in China in 2017, Huawei was the clear leader shipping 102 million units, followed by OPPO and Vivo, with shipments of 77.6 million and 72.2 million units respectively. Apple was fourth with shipments of 51.1 million units, followed closely by Xiaomi with 50.1 million units. The top five companies accounted for 78 percent of the China market.

In 2015, a large number of new smartphone companies and models came onto the market, and consumers responded to the greater number of choices available by dramatically increasing cell phone purchases. With more competition and an expanded market, Apple’s market share declined from its peak of 13.6 percent in 2015 to 9.6 percent in 2016. In both 2016 and 2017, smartphone shipments by Huawei, OPPO and Vivo increased dramatically and their market shares expanded. Xiaomi’s market share slipped in 2016, but increased significantly in 2017. Meanwhile, Apple’s shipments have been relatively flat during this period, causing its market share to drift lower to 9.3 percent by the end of 2017.

In the third quarter of 2018, Huawei, OPPO and Vivo all increased unit sales over the second quarter — Vivo by 14 percent, OPPO by 7.5 percent and Huawei by 6.6 percent. Xiaomi’s unit sales slipped by 4 percent, while Apple registered a 10 percent decrease. Chinese consumers are still buying smartphones — they just aren’t buying Apple’s!

One of Apple’s problems is that its smartphones are at the high end of the market in terms of price, and this is especially challenging in China where consumers have a fundamentally different — and lower — cost perspective than consumers in the United States. Counterpoint, a technology research firm, has estimated that Apple has 79 percent of the global market for phones over $800. In China, Apple occupied 65 percent of the $600 or over segment, but only 11 percent of the market for handsets priced from $400 to $600. With Chinese consumers’ emphasis on affordability, and with smartphone users trading in their phones every 18 months, the market for lower priced phones is clearly growing much faster than the premium segment.

China’s lower cost perspective, in combination with the way in which the country has developed, has created two markets in the country — a purely local market that is characterized by low price and low technology, and a foreign/local market that is characterized by high price and high technology. Two key characteristics of China’s purely local market is that first, it keeps growing, and that secondly, the local companies don’t just stand still. Many improve their quality and technology. Apple has clearly been focused on the foreign/local market where it is at a comparable price point with Samsung.

Meanwhile, the companies competing in the purely local market for smartphones have been growing their sales and developing their products. Just like in appliances, passenger cars and almost every other product being made in China today, the local companies are making better and better products that are more affordable than the products made by their international competitors. Among the local companies, for example, Huawei is leading the way in the development of 5G technology, an area where Apple has lagged. The ultimate challenge for Apple will occur when the Chinese smartphone makers take their more affordable products and begin to compete in Apple’s markets outside China. Maybe that’s what the stock market was worried about when it slashed Apple’s market value by $57 billion?

In summary, Apple’s problem in China is not simply a slowing Chinese economy as Cook suggests. Smartphone shipments in China have been falling for at least six quarters. With an already high smartphone penetration rate, the market is saturated, and Chinese consumers have been watching and waiting for the development of new features like 5G. With respect to Apple itself, the company’s products are too high priced for the bulk of the China market where the competition is only getting stronger. Finally, in a market where users are constantly upgrading their phones, Apple has not done a particularly good job as far as introducing new products and innovations. The net result has been a significant loss of market share in the world’s largest market for smartphones.

No comments yet... Be the first to leave a reply!